Can Modular Housing Deliver for the Private Rented Sector?

The Government wants more than 100,000 modular homes in the UK to support its target of 1m new homes by 2020. This effectively means that in just three years it wants to increase the current levels of modular home delivery by 55 per cent as supply levels of UK modular homes stand at just 15,000 a year.

Increasing the supply of new homes for the private rental sector is also a central tenet of policy maker’s strategy to hit these numbers. But could the modular delivery model support the supply of homes to the private rented sector (PRS) to the scale that they hope for? There have been recent moves by key companies in the sector to choose modular but is this a viable solution for ramping up supply of PRS homes?

Why is Modular Construction Particularly Relevant to the PRS?

Modular Construction is the process where either a whole building, or parts thereof, are produced under controlled plant conditions off site and delivered and assembled as large volumetric components or as substantial elements of a building. Modules are designed using many of the same materials and codes from traditional construction methods but can be produced in silo, out of sequence to condense the master programme. The ability to utilise different materials that cannot be used as individual components on a traditional build has the potential to drive innovation in construction.

Financial services giant Legal & General has built the largest home-building factory in Europe in a bid to shake up UK housing by manufacturing up to 3,500 homes per year. And The Homes and Communities Agency (HCA) has now said that it plans to invest some of its £3bn Home Building Fund in modular construction factories. (What have they delivered to date?)

From our experience of consulting on modular schemes, we would choose to highlight the efficiencies in the modular construction process that produce cost savings and increase speed to market. But from our perspective there are also areas of the delivery model where there is inherent risk, most notably at the pre-construction stage.

And, in our view, this risk has not been adequately recognised among the industry clamour surrounding modular and the optimism that it might deliver the scale of housing the country so desperately needs. The PRS has its own very distinct set of challenges and a very different financial model – so, we would ask the question, can modular construction methods deliver for the PRS?

Pre-Construction – Commitment Required!

There is a high level of commitment in making the decision to develop a modular scheme and finding the funding for it from the outset of a project. Yes, there are undeniable benefits in terms of faster delivery time on-site and therefore earlier revenue generation. But the financial commitment at the pre-construction stage of the project lifecycle is certainly higher and represents a significant undertaking.

From experience, we know that the time period from order placement to the first module being onsite is circa 16 weeks (on a typical 150 bed / unit scheme). There is a period of six weeks from planning determination, then the typical discharge of pre-commencement conditions is between eight to ten weeks, therefore the manufacturing process needs to have commenced, to maximise the on-site programme saving. There is actually a lot longer than this as there is the design and tender stage to go through, and planning conditions often take a lot longer.

This is a commitment of higher expenditure than on conventional residential developments. For each modular project, a specific design and product is going to be manufactured and tailored to the relevant scheme. 70 per cent of this product is being built off site and at least a 40 per cent deposit will have to go down to cover the costs at the point of order. Compared to conventional schemes, this is a far higher cost to be delivered up front. It also has significant ramifications as the specificity of the product means that the developer is then “locked in” to ensuring that a relevant return can be achieved at the project’s completion.

On conventional schemes a developer might put down 10 to 20 per cent of costs in terms of piling, cabling and foundations. And elements of the scheme can be pre-sold or brought to market in stages thereby bringing forward tranches of revenue. With a modular delivery model for the PRS, there is the period of manufacture to see out before onsite work can began and the final product will be delivered on site at one point in time (and from which revenue accumulation will begin).

For residential projects built via conventional methods, developers have the ability to wait until the fit out process to commit to the final product, meaning they can tailor the product to market conditions and consumer demand. But from moment that the decision to build a scheme via modular methods, they are committed to that final fit out and product.

Funding Modular PRS Schemes

With 40 per cent of the total project costs being paid upfront then interest costs are going to be a significant factor in the ongoing delivery model and become a serious consideration for cost planning. These costs have to be offset against the potential prospect of earlier revenue generation – via a programme of modular delivery – to ensure that this form of delivery is financially enticing.

It may well be that these larger modular schemes will attract investors with deep pockets that can produce the required level of outlay from the start of a project. But if the developer cannot come up with the relevant cash in this way then it will have to be funded via lenders, which will have significant implications around the viability of the scheme. Until a track record of schemes is available, the reality is that the majority of major lenders will remain sceptical about projects of this type.

As you go up the scale, and begin to look at larger modular schemes – particularly in light of the numbers the government is talking about – then the bigger the project, the longer the lead in, and the higher that initial investment becomes. While this is a challenge that is not insurmountable, it will still have to bear serious consideration.

How could risk impact the delivery of modular schemes?

There is also inherent risk in this period of time between planning consent and the moment that revenue can be derived from the development that does not exist to the same extent on conventional schemes. Because of the time scale involved and “fixed” nature of the modular product, any changes to market demand and client requirements cannot be addressed as they might be via onsite construction methods. This includes everything from market drivers on room mix, through to amenity spaces and even the availability of specifics products, i.e. kitchens, bathroom units and so on.

Early design freezes will be required to ensure modular schemes actually achieve reduced delivery programmes. Design revisions that would occur via traditional onsite construction methods are not compatible with the modular world; they would set back the manufacturing process or, at worst, require whole product runs to be abandoned. This is also a consideration for the planning process too due to the limited ability of design revisions throughout the construction lifecycle.

So, commitment remains the key word – a developer must commit at the planning stage to produce a modular scheme. They could wait for consent but, as with any scheme, that will mean eight weeks waiting for approval. The implication for a modular project is that very little can be done during this time because of the risk of pushing the green light on design production. And this will set the delivery timetable back thereby undermining the gains on the completion timing that modular should enable.

If there are any issues from a planning point of view with a modular scheme, then the units that are already under construction would have to be revised or abandoned altogether, which would add considerable expense and time delays to the project. And that would only be the case if there were requisite manufacturing slots available in the production line, which is already churning out 10,000+ units.

Speed to Market – How the Model Adds Up

With all of the above in mind, modular construction may in many ways look more expensive but it is speed of delivery which provides the cost benefit. It is the savings on the programme, on the capital costs by scale where money can be made.

Modular housing should typically produce a 10 to 15 per cent saving on time; the earlier finish date allows the scheme to generate revenue at a much earlier point in the lifecycle of a project than conventional construction methods on small to medium sized developments. This is where the key advantage lies.

The difference between additional revenue generation at the completion of modular construction and the period of uncertainty at its start dictates the profitability of this form of building. The other key consideration is, of course, the risk around key decision making at this early point in the lifecycle of the project.

Scale of Delivery is the Key to Modular Success

The reality is that modular may provide real cost benefits for largescale PRS schemes where speed to market is of critical importance and product homogenisation is of less concern. The economies of scale on a pipeline of modular projects will only really kick in when unit development reaches a certain critical mass, meaning that successful schemes can be replicated, components re-used and the right supply chain falls into place. This improvement in delivery time may then hold the key to the sector being able to increase the number of PRS schemes and brining more rental supply to market.

We also know from our experience of working on hotel projects with Whitbread that “verticality” is key. Anything over six storeys becomes viable as it produces better use of space – particularly in dense, urban locations – and also introduces more economies of scale for the supply chain, and the units that can be manufactured offsite. The resulting reduction in costs changes increases the project return and positively impacts the timescales for delivery.

However, I am of the view that the critical pre-construction issues set out in the paper are not being given full consideration when discussing modular as a largescale solution to additional PRS units. That is not to say that it will not work. There are obvious benefits, but developers (and policy makers) need to be aware of the implications of the modular development model and the challenges it brings. These will improve over time as the expertise of contractors’ increases and supply chain for modular grows.

As the level of modular construction develops in the UK, there are further, positive impacts to consider that will, ultimately, influence the decision to utilise modular construction techniques. There are obvious environmental advantages such as the reduction in waste, of on-site noise and disruption, and the overall impact on construction, particularly in urban areas. Construction tolerances achievable within a factory environment are found to surpass on site construction methodologies.

Modular offers an attractive working environment for construction employees. They are offered a single place of work, are able to settle themselves and their families in the local area, and work in a controlled safe environment.

In Conclusion

To achieve the required return, the delivery model has to be closely scrutinised and the requisite level of funding in place for modular schemes in the PRS to prosper. The pre-construction element of the model has not been given enough consideration in regards to the viability of these schemes, in my opinion.

The success of modular PRS schemes hinges on its ability to deliver a large amount of product to market rapidly and start generating revenue across the scheme ahead of the conventional model. In time, with the development of better supply chains, a streamlined planning model and improved industry awareness then the risks involved will diminish. But, until that time, it is essential that those involved with the schemes go into the project with their eyes open and understand the strictures of the development timeline.

Lots of developers are using a mix of traditional and modern methods, with bathroom pods being the most common example of prefabrication within new developments. However, developers still find tradition construction methods to be more commercially attractive, especially in an uncertain market when it comes down to pounds and the pennies. But the level of modular production in facilities across the UK is increasing all the time. And its current success, we believe, hinges on “verticality” and the ability to produce largescale developments which adhere closely to the delivery model we include, while recognising some of the inherent risks involved from the outset.